Key Rate Exposures, Bucket Shifts, and Immunization

DV01 and modified duration assume that rates at all maturities move by exactly the same amount — the parallel shift. That is a useful simplifying assumption but a factually wrong one: on most trading days the 2-year Treasury yield moves by a different amount than the 10-year or the 30-year, and sometimes they even move in opposite directions. A liability-driven investor who "duration-matches" a pension liability is DV01-neutral to a parallel shift, but still exposed to a curve twist that raises short rates while long rates stay flat.

• define a key rate shift and describe how it is constructed to be localised around one maturity point;
• compute a key-rate DV01 from a sequence of price calculations, one per shift;
• state the decomposition property: the sum of all key-rate DV01s equals the parallel-shift DV01;
• identify the key-rate exposure profile of a par bond, a zero-coupon bond, and a mortgage;
• construct a hedge portfolio from key-rate DV01s using four liquid benchmark bonds;
• explain duration immunisation — matching assets and liabilities on the key-rate DV01 vector — and why it requires more instruments than a simple DV01 match.

1. 1. The failure of the parallel-shift assumption
2. 1. Key rate shifts defined
3. 1. Key-rate DV01 and key-rate duration
4. 1. Key-rate exposure profiles: par bonds vs zeros vs mortgages
5. 1. Hedging with key-rate exposures
6. 1. Immunization: matching assets and liabilities